The SEC last month proposed rule changes that would require companies to include in certain regulatory filings quantitative and qualitative information about climate change. The proposals are wide ranging and, if they’re adopted, companies would be required to develop, gather and disclose a significant amount of information.
Although the SEC is soliciting comments and it may take several months for the commission to consider the feedback before adopting final rules, companies and their boards should begin preparing for the possibility that the changes will be adopted largely as proposed by the end of the year.
It usually does not make sense to dedicate resources toward compliance when SEC rules are still at the proposal phase, but these proposed changes are quite different. Their scope and complexity may make them costly for companies if adopted. Even with generous transition provisions, companies may still not have time to develop the processes necessary to comply. For these reasons, public companies and their boards of directors should start working now to prepare for a whole new disclosure regime. They can do this by taking a series of steps.
Step 1: Take an inventory
The SEC’s climate change rule proposals did not arise in a vacuum. Many companies have been providing information about greenhouse gas (GHG) emissions, the risks arising from climate change and governance over climate change matters in communications outside of SEC reports. These disclosures are provided under a variety of different standards, but many companies already use the TCFD and GHG Protocol standards on which the SEC based its own proposed requirements.
Given this existing disclosure landscape, companies should take an inventory of the information they are already providing on climate change, determine how that information is gathered and how quantitative metrics are calculated, and assess their information-gathering and communication process.
For example, the SEC’s proposed rule would require specific disclosure of a public company’s direct GHG emissions (Scope 1) and indirect GHG emissions (Scope 2), as well as indirect emissions from upstream and downstream activities (Scope 3). In the case of Scope 3 emissions this would apply only if the information is material or if the company has set a goal that includes Scope 3 emissions. Disclosures concerning Scope 1 and Scope 2 emissions would eventually be subject to external attestation by a third-party service provider.
In preparation for having to comply, a company should begin determining what information along these lines is currently developed for both internal and external purposes. For some companies, Scope 1 and Scope 2 (and perhaps to a lesser extent Scope 3) GHG emissions data may already be provided to external parties, so the analysis can then shift to evaluating the process for collecting relevant information and calculating metrics in a way that could ultimately be subject to third-party attestation.
Other companies may need to start from scratch in determining how best to comply with any final rules. Without completing the initial inventory, companies may find it difficult to effectively make the most of resources and existing transparency efforts.
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Step 2: Draw a map
One of the most effective ways to assess a company’s existing transparency efforts is to map the disclosures it provides under the existing disclosure standards set by various organizations. This can provide a clear indication of where the company’s disclosure efforts may fall short when judged in the context of applicable voluntary standards.
A company can now map its existing disclosures to the corresponding proposed SEC requirements to further understand what additional work may be necessary. Once potential gaps are identified, a company can dedicate its resources to better understanding the applicable disclosure requirement and to developing an effective compliance framework. If it does not undertake this mapping exercise, a company may not effectively use existing systems and processes when the final SEC requirements are adopted.
Step 3: Revisit targets and goals
Among other provisions, the SEC’s proposals would require the disclosure of information about climate-related goals or targets that public companies have set, including their scope, data demonstrating progress toward meeting them, plans for meeting them and information about the use of carbon offsets or renewable energy certificates.
Companies should revisit their approach to goals and targets in light of these proposed requirements. Although it is unlikely a company would retract goals or targets due to the proposed disclosure requirements, it will be important to assess how future disclosures will be prepared to demonstrate progress toward meeting existing goals or targets. Companies should also consider the potential disclosure obligations before setting any new targets or goals, including the possibility that disclosing Scope 3 GHG emissions targets or goals could result in the need to disclose Scope 3 emissions data in the company’s SEC reports.
Step 4: Get the governance right
The SEC’s proposed disclosure requirements provide a detailed roadmap of the governance and risk-management activities the commission would expect to see implemented for climate change risks. Before the changes go into effect, boards have a valuable window in which to assess the company’s overall approach to governance oversight of climate-related risks. This assessment should begin with identifying the climate-related risks the company faces and evaluating how those have affected, or are reasonably likely to affect, the company’s strategy, business model and outlook across all time horizons.
Based on the information developed through the initial assessment, the board should evaluate how it has been involved in overseeing climate-related risks in the past, and how that effort can be improved in the future. The board should consider how to appropriately allocate responsibilities among board members and committees.
The company should clearly document the board’s role and that of its committees in overseeing climate-related risks and the company’s climate-related goals and targets. In addition, management’s role in the oversight of climate-related risks should be clearly articulated and activities should be conducted in accordance with those parameters. Finally, management and the board should be involved in assessing and improving the processes for identifying, assessing and managing climate-related risks and opportunities.
Step 5: Preview financial statement changes
The SEC’s proposed requirements would necessitate more detailed disclosure regarding the financial impacts of climate-related conditions, events and transition activities, as well as expenditures in certain circumstances. The board’s audit committee should take the lead, with management’s assistance, in understanding how these requirements, if adopted as proposed, would impact the company’s financial statements.
The audit committee and management should also open a dialogue with the company’s auditors to understand how the changes to the financial statements might impact the audit so that no surprises happen when and if the rule changes go into effect.
David Lynn is a partner and co-chair of Morrison & Foerster’s corporate finance and capital markets practice. He is a former chief counsel of the SEC’s division of corporation finance.
